American Consequences - June 2017

The Fed Don’t Mean

A Conversation with Julian Assange Page 48

Real Money and Why You Need It Now Page 28

a Thing Page 44 AMERICAN CONSEQUENCES

I D E A S T H A T M A T T E R

E D I T E D B Y P . J . O ’ R O U R K E

Introducing the Escher Economy page 14

J U N E 2 0 1 7

WELCOME TO AMERICAN CONSEQUENCES

From Editor in Chief P.J. O’Rourke

I make fun of things for a living. But over the years, I’ve found that making fun of things can be an excellent way to understand them. And making fun also allows me to be a neutral referee. I don’t take sides. The absurd is the absurd whether you find it on the left, on the right, or in the middle. An absurdist is well prepared to see that ideas matter. Just take any idea and reduce it to the absurd and you’ll see what really matters and what doesn’t. For example, if enough Americans get the idea that the North American Free Trade Agreement is a way for Canadians to destroy the American ice industry and gain a global monopoly on hockey rinks, there will be consequences – like a run on ice-cube trays at Target and strong feelings against folks in plaid flannel shirts and earflap hats who say “eh” at the end of their sentences. The other writers for American Consequences will give you something more substantive than that to think about. But I promise you I won’t. Regards, P.J. O’Rourke

Dear reader, Welcome to the first issue of our magazine. Stansberry Research and I are doing something different in the field of financial news and newsletters. For about 20 years, Stansberry Research has been known for its investment tactics and strategies and for its examination of the macro- and microeconomic trends that drive marketplace shifts. But there’s more to Stansberry Research than wise analysis and practical stock, bond, and commodity advice. Behind the expertise are Stansberry’s people. And behind the people are ideas. Ideas matter. Ideas shape the market. Those ideas also have social, moral, intellectual, and political effects. The ideas people have lead to the ways people behave. And the ways people behave lead to... American Consequences . We’re establishing a forum where good minds tackle current ideas and think through the results those ideas will have. I’m the editor of this magazine not because I know a lot about business, finance, and economics, but precisely because I don’t.

CONTENTS

JUNE 2017— ISSUE 1

14

22

36

28

48

Editor in Chief: P.J. O’Rourke Editorial Director: Carli Flippen Editor: Steven Longenecker Contributing Editors: AMERICAN CONSEQUENCES

44 The Fed Don’t Mean a Thing

05 Letter from the Editor 10 What Moved the Market 14  Introducing the Escher Economy BY PORTER STANSBERRY 22 The Strange, Shape- Shifting Symbol of Value BY P.J. O’ROURKE 28 Real Money and Why You Need It Now BY BILL BONNER 36 Deciphering ‘Fed Speak’ BY P.J. O’ROURKE

BY DR. DAVID EIFRIG 48 A Conversation With... JULIAN ASSANGE 52 Your Last Bull Market BY DR. STEVE SJUGGERUD 58 Get Me a Quote on That 60 The Final Word BY BUCK SEXTON

Porter Stansberry, Dr. Steve Sjuggerud, Dr. David Eifrig, Bill Bonner, Buck Sexton Newswire Editors: Scott Garliss, John Gillin, Greg Diamond Cartoon Director: Frank Stansberry Contributing Cartoonists: Michael Ramirez Creative Director: Ricky D’Andrea This Month’s Cover: Nigel Sussman Advertising: Jared Kelly Advertising inquiries: advertising@ americanconsequences.com Editorial feedback: feedback@ americanconsequences.com

INSIDE THIS ISSUE

From Editor Steven Longenecker

Former Goldman Sachs derivatives trader Dr. David Eifrig explains how interest rates really affect your investments... and why the Fed rate increase this week is essentially meaningless... While 25-year industry veteran Dr. Steve Sjuggerud explains why this stock bull market could be your LAST – and how to play it. (If you’re invested in stocks, this will both be a comfort... and a warning.) Julian Assange , one of the most controversial figures you can bring up in polite conversa- tion, shares important insight about the “War of Leaks” in DC... Whether you support his exposure of state secrets or believe he’s endan- gered U.S. lives, he’s worth listening to. And nationally syndicated talk radio program host Buck Sexton has advice for President Trump on the Beltway brawl to come – wading through a siege of journalists, embittered Hillary voters, and self-inflicted wounds. As a former CIA officer, Buck doesn’t pull any punches... and he doesn’t advise the President to, either. We hope you enjoy the issue. We enjoyed

In our inaugural issue of American Consequences , you’ll hear from editor in chief P.J. O’Rourke as he points his finger at one of the biggest absurdities in the world today – the power of the Federal Reserve... And he wonders, what if he could have his own personal Central Bank? And he deciphers a speech from the Federal Reserve – putting into plain words the true intentions of the Fed. Like this definition for “forecaster”: somebody who’s not only wrong, but gets paid for it . Bill Bonner , the founder of our nation’s largest underground news network, explains how money has changed dramatically in recent years – and why there’s only ONE currency that will truly protect your savings going forward. You’ll understand why Porter Stansberry has called Bill one of the great minds in America today. As for Porter, a financial analyst who has been labeled “remarkably prescient” by Barron’s magazine, he’s introducing the “Escher Economy”... It’s all about how today’s risk-free money policies are warping capital markets, making them look like one of M.C. Escher’s most famous. There is no up . There is no down . And how, as a result, investors may not be able to find safety in the next crisis.

putting it together. Until next month, Steven Longenecker Editor, American Consequences

2 | June 2017

Big news… Porter Stansberry is back on the air hosting Stansberry Investor Hour , with brilliant co-host: Buck Sexton . Buck is a former intelligence officer for the CIA, and worked for the Intelligence Department of the NYPD. Together, Porter and Buck are interviewing some of the most influential (and sometimes controversial) figures in the world. From Julian Assange, the besieged founder of WikiLeaks, to Cactus Schroeder, a Texan oil man known for inking multi-billion dollar deals, our guest list is never short on notoriety. Every Thursday , the Stansberry Investor Hour podcast will upload to iTunes, keeping investors (like you) in touch with what’s happening in the markets and critical world events.

To ensure you never miss an episode of Stansberry Investor Hour… Step 1: Simply visit the iTunes store by clicking here Step 2: Click “Subscribe”

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IT’S ALL TOTALLY FREE OF CHARGE. We simply want you and every Stansberry Research subscriber to have convenient, unconditional access. So be sure not to miss out. Subscribe to Stansberry Research Hour – and even check out Porter’s past interviews – by accessing our iTunes podcast archive.

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LETTER FROMTHE EDITOR

P.J. O’ROURKE

My Personal Central Bank

Most of my colleagues here at American Consequences are skeptical about Central Banks. Not me. I like them. I want one of my own. Of course, I don’t want an enormous Central Bank like the Federal Reserve. Where would I put it? Although we live in a big old house in the country, we don’t have enough bedrooms to host seven Federal Reserve Board Governors and a dozen Reserve Bank Presidents at those Federal Open Market Committee (FOMC) meetings they have all the time. We’d have to put some of them in the hayloft. (Do they bring their families?) Plus, we’d have to feed them. I hope FOMC

members are okay with weenies and burgers on the grill and a cooler full of beer. No, what I want is a compact, household-size type of Central Bank for my own personal use. A small, handy O’Rourke Central Bank that would fit in the laundry room or in the mudroom between the dog kennels. The reason I want my own Central Bank is that I’ve been reading up on the Federal Reserve Act of 1913 and the mandate it gave to the Federal Reserve Bank – specifically, the mandate as it was amended during the 1970s and ‘80s in “Section 2A. Monetary policy objectives.”

American Consequences | 5

I have two monetary policy objectives. 1. Monetary objective: Get rich. 2. Policy objective: Stay rich. Therefore, I was interested to see what Section 2A had to say, which I quote below with my own comments in brackets. The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates [ e.g. the O’Rourke checking account balance and Visa card limit ] commensurate with the [ my ] economy’s long run potential to increase produc- tion [ maybe someone will turn one of my books into a hit movie ], so as to promote effectively the goals of maximum em- ployment [ I could do without “maximum employment,” but I’ve got three kids to put through college so it’s not like I’ve got a choice ], stable prices [ especially for the shoes and clothes my wife and daughters shop for on the Internet ], and moderate long-term interest rates [ on the credit card debt to pay for those shoes and clothes ]. My kind of mandate! But there’s a problem with getting the United States Federal Reserve Bank to exercise its mandate on my individual behalf and help me reach my monetary policy objectives. I have to stand in line. The Federal Reserve is a large establishment for use by the general public – kind of like the men’s room at Penn Station in New York. And, kind of like the men’s room at Penn Station, all sorts of stuff goes on inside the

Fed that I don’t want anything to do with, such as mopping up government deficits and pissing on free enterprise. I prefer a private facility. In fact, I prefer a private everything – private railroad car, private jet, private tropical island. But these are expensive. According to what I’ve read about the history of central banking, a private Central Bank would seem have a zero-dollar purchase price and virtually no maintenance costs. (An extremely condensed history of central banking: In 1694, the English King William III was fighting the Nine Years’ War with France and ran out of money. He said, “Let’s have a Bank of England to borrow some from.” The Chancellor of the Exchequer Charles Montagu, 1st Earl of Halifax, said, “Jolly good idea.” And Bob’s your uncle.) Most of what a Central Bank does is “open market operations.” These consist of buying bonds from a government. In the case of the O’Rourke Central Bank, I’m the government. I have any number of “PJ Treasuries,” “P-Bills,” “J-Notes,” etc., all neatly hand-lettered on my personalized stationary and available in denominations up to $1 godzillion with maturities ranging from “after I’m dead” to “when hell freezes over.” A Central Bank pays for bonds by issuing currency. I’ll use the color Xerox down at the copy store. It’s not counterfeiting when a Central Bank does it. Of course, my Central Bank will need to be a “politically independent” institution, the way the Federal Reserve is. The President of the United States can’t just tell the Chairman

6 | June 2017

of the Federal Reserve what to do. On the other hand, the President does appoint the Fed Chairman and the Fed governors too. So I’m going to appoint my dogs, Clio, Georgie, and Bodey. They’re very cute dogs so I don’t foresee any problems with Senate confirmation. (Senators rejecting cute dogs would cause a furious national outcry on Facebook and Twitter.) I assure you my dogs are very independent. If I tell them, “sit,” or “stay,” or “come,” they just look at me with dull incomprehension and keep on chasing squirrels. And yet I think I can get them to give me a unanimous bark of approval for pursuing my monetary policy objectives... “Clio, Georgie, Bodey – want a treat?!” Now, what else can I get my Central Bank to do for me? A Central Bank manages the currency and money supply of a nation. In this case that’s the United States of Me. I’m headed back to the Xerox machine at the copy shop right now. A Central Bank also manages a nation’s interest rates. There are a number of different interest rates that a Central Bank manages – target rate, nominal rate, effective rate, discount rate. Therefore my central bank will manage interest rates so that I, too, have a variety to choose from. There’s that ultra-low rate on my Visa card balance that I mentioned before. But in other situations, I’d like other rates. No more 0.4% six-month CDs, please. The Reserve Bank of My House will make sure

that the return on my savings account falls somewhere between Venezuela government bond yields and Mafia loan shark vigorish. My Central Bank can take care of this because another thing Central Banks do is oversee commercial banks. And my local bank could use a little oversight. Next time I go there I’ll bring Georgie, the chairman of my Fed. Georgie is an adorable black Lab, but she also has teeth like a set of steak knives and a deep and fearsome growl. Then I’ll explain to the bank manager that when I balanced my checkbook, yes, I did add a $1,230 check I wrote to my previous balance of $984 instead of subtracting the $1,230 from the $984. But that’s what a government does with “off-budget” federal spending involving such programs as Social Security. Therefore, using official U.S. federal budget math, I now have $2,214 in my checking account, not -$246. And Georgie will provide oversight by governments and individuals is that governments are much stupider. The main difference between governments and individuals is that governments have Central Banks and individuals don’t. The other main difference between

American Consequences | 7

Central Banks and individuals don’t. The other main difference between governments and individuals is that governments are much stupider. This is because governments have Central Banks to fund their stupidity. Individuals are forced to be “fiscal conservatives.” If we become ridiculously indebted far beyond our ability to repay, we lose the house, the car, and the boat.

By permission Michael Ramirez and Creators Syndicate, Inc.

Individuals are required to have a sensible “macroeconomic policy.” It’s fine for the Fed to ruin whole sectors of the economy by creating an immense pool of assets that only exist on paper. But when an individual does that, he’s Bernie Madoff. Individuals are constrained by a cautious and moderate “foreign policy.” An individual can’t afford to invade a neighbor’s home. He’ll be shot (especially up here in rural New England where I live). Individuals don’t have the assets to damage the social fabric with public policies that turn inner cities into war zones. The only individuals who have those kinds of assets are drug lords... and they get arrested. So... I wonder. If I had my own Central Bank and the unlimited power that an unlimited amount of money would give me, would I start to become as stupid as a government? What’s to stop me? Regards, P.J. O’Rourke

going, “ Grrrrr... ” That’s one more thing Central Banks do – facilitate government debt and deficits. In fact, harking back to King Billy in 1694, that’s all Central Banks do. And I’ve got plenty of debt and deficits already and don’t need any more. Also note that, per King Billy, the debt and deficits always seem to be used to finance bad ideas such as a Nine Years’ War with France. Or nowadays, massive entitlement programs that devastate work ethic, destroy family ties, and strip people of their personal responsibility and self-respect. In my case the debt and deficits would probably finance a Harley-Davidson. At my age this would quickly turn me into a “rolling organ donor.” Which makes me wonder whether having my own personal Central Bank is such a good idea after all. The main difference between governments and individuals is that governments have

8 | June 2017

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What Moved the Market

MAY 24 CBO releases Obamacare Repeal analysis The focus of the report was on how many people stand to lose coverage (23 million) and its deficit effect (cut $119 billion through 2026). A rational person would ask why all of this was not scored before the first vote in the House and subsequent keg party in the Rose Garden. MAY 25 OPEC extends oil supply cut At this point, the markets expected this and it has become a “sell the news” type of event. So the trend likely remains positive near term but prices can’t go up indefinitely. You do have to have a pull back every now and again.

MAY 26 General Motors cheating on emissions New report that General Motors (GM) accused of cheating on emissions standards. The lawsuit is directed at their diesel truck unit. Fiat Chrysler has been dealing with similar accusations and has agreed to pay an $800 million fine. That is just the beginning. We have been pounding the table about lower used car prices and the damage that is doing to lenders and rental car companies. Diesel is the next shoe to drop. Couple that with cheating on emissions and this mess is morphing into a wild fire. MAY 30 Barron’s cover story on Ford The article is excited over the

EDITORS: Scott Garliss John Gillin Greg Diamond

Tune in to Stansberry

Newswire , live every morning and afternoon, at 8:30am and 4:30 pm.

10 | June 2017

CEO change from Mark Fields to Jim Hackett. They like his having run the Ford Smart Mobility unit and think the self-driving fleet- management business could be more profitable for Ford down the road than their current car-making business is today. (At 2% margins, it’s hard to be worse.) Electric technology is a game changer and it’s here to stay. However, we bet that Goldman’s estimates on profits are likely too high. It will take time for that to play out. In the meantime, there is serious pain in auto land around subprime lending and the flood of used cars coming onto the market. If you want to invest in self-driving cars and the technology revolution around those platforms, why not invest in names with growth potential like Nvidia (NVDA), Intel (INTC), and Microsoft (MSFT). JUNE 1 The U.S. walks from Paris Accord President Trump has opted out of the Paris Accord to save jobs and expects to negotiate a better deal for

Electric technology is a game changer and it’s here to stay. However, we bet that Goldman’s estimates on profits are likely too high. It will take time for that to play out. In the meantime, there is serious pain in auto land around subprime lending and the flood of used cars coming onto the market.

the U.S. down the road. Sectors that benefit from the cancelled Accord are oil, though more drilling and new projects would eventually pressure oil prices... Coal, particularly clean coal, also benefit. Utilities and any company involved with cement, aluminum, iron and steel rally. Even automobile stocks rallied – at least initially. Don’t forget these are bad business models. The losers are solar and all alt-energy related names. Same with electric car maker Tesla (TSLA). JUNE 8 Former FBI director James Comey testifies The month’s political “main event” of Comey’s testimony

underwhelmed investors. The questions and answers didn’t produce anything new and markets rallied after selling off. JUNE 8 House votes on Dodd-Frank In addition, the House approved a sweeping bill that makes significant headway in changing cumbersome Dodd-Frank regulations. But the problem is that in its current form, it won’t get any play in the Senate. All the legislators have their own agendas and will want to make their mark on the new rules. It’s a start, but like healthcare reform, it’s a long way from everyone singing from the same sheet of music.

American Consequences | 11

JUNE 9 UK election results in hung Parliament Theresa May’s decision to call a snap election looks to have been the wrong call as her party failed to keep as many seats prior to the election and no party has the majority rule. She has stated she will not resign and will seek permission from the Queen to form a government. Brexit negotiations will most likely be more complicated and the British Pound was pummeled, falling as much The intent of this rule is to protect investors from getting over-charged for investment advice. Department of Labor analysis has found that many, many people have had their money invested in higher cost products when there are lower cost products available and they do the same thing. Seems fair. However, the Labor Secretary, Mr. Acosta, has left open a rewrite of the as 2.4%. JUNE 9 Fiduciary Rule implemented

legislation that will curtail a lot of the legislated rules. The argument has to do with pulling back regulations to create a more business friendly environment. There must be a middle ground. People need sound advice and when the markets get rattled, having a real hand to hold will aid performance. But the fee structure is disrupted and working towards a fair resolution as opposed to lobbying for status quo is a logical plan. JUNE 13 & 14 Federal Open Market Committee (FOMC) meeting As expected, the FOMC raised the federal funds rate by 25 basis points. What is more important is the language that follows the decision around the inflation picture and what the Fed intends to do with its balance sheet... The comment that they are “monitoring inflation developments closely” does not instill confidence on growth. Inflation is a key signal, and the data continues to moderate.

Rising rates coupled with slowing inflation typically leads to an erosion in equity value. Keeping it simple, the Fed owns trillions of dollars’ worth of Treasury and mortgage-backed debt. Much of this is longer in duration. The perfect plan would be a gradual unwind- selling of these assets, which would ever so slightly raise long-term rates. The easiest way to conceptualize this is the U.S. – the sovereign buyer – has been a consistent buyer of these assets for years now. Removing that buyer would cause prices to dip and interest rates to rise. Exactly what financials and insurance companies are banking on. WATCH THESE DATES June 23 : Markit U.S. Manufacturing, Services, and Composite Purchasing Managers Index – gives us a good idea on growth. June 30 : PCE inflation data released. This is a key inflation gauge for the Fed. July 5 : FOMC minutes released.

12 | June 2017

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By Porter Stansberry

Introducing the Escher Economy

saved the king’s bacon, Law convinced the king to give him a monopoly on trade with the new world – in Louisiana. The combination of virtually limitless paper money and the hottest initial public offering (“IPO”) in history saw Law pay off the entire French government’s debt just by issuing another 300,000 shares of the Mississippi Company. The share price, which went public at 75 livres, eventually rose to 15,000 before the peak. It was this bubble... the forerunner to every modern financial bubble... that saw the creation of the word “millionaire.”

ABOUT FIVE YEARS AGO... Investors around the world began piling into Japanese stocks. It was a surprising move. Japanese stocks have been a virtual graveyard for capital since the last 1980s. That’s when Japan’s big real estate and investment bubble collapsed. The Japanese “Dow” – the Nikkei 225 – briefly soared from around 10,000 to more than 40,000... and then collapsed. Over the next 20 years, every rally in Japan was followed by still yet another, bigger decline. By 2009, the Japanese stock market was still down over 60% from its peak. (See chart to the right.) So what was it that spurred global investor interest a few years ago? Did Japan’s economy suddenly come back to life? No. Japan has consistently had the worst economy among the G20 group of major economies. Economic growth hasn’t been above 2% since 2012. Was there some breakthrough in solving

Japan’s big demographic problems? No. Japan’s population is declining. Japan is expected to lose more than 30% of its population by 2050. So... why were investors suddenly interested in Japan? JAPAN WENT ‘JOHN John Law was the Scottish rogue and murderer who convinced the French King Louis the XV to allow him to set up one of the world’s first central banks, the Banque Générale, in 1716. The bank brought paper money to France and allowed the king to finance his soaring debts. Having LAW’ WITH ITS CENTRAL BANK

American Consequences | 15

So naturally, Japan captured investors’ attentions when it announced in 2012 that it would vastly increase the asset purchases of its central bank... And its central bank – the Bank of Japan – wouldn’t just buy Japanese government bonds... Japan was the first major economy in the world to see its central bank begin to buy huge amounts of stocks . $30 billion or so per year. In an attempt to make sure these purchases weren’t politicized, the bank explained it wouldn’t buy stock directly (it wouldn’t pick stocks). It would only buy via exchange-traded funds that allocate capital according to the structure of various preexisting indexes. As you’d imagine, this policy has produced a boom in Japanese stocks. And it has attracted a lot of “hot money” from around the world. Buying Japanese stocks between 2012 and 2016 (as they doubled) was virtually risk-free, thanks to the size of the Bank of Japan’s

campaign. As Jesper Koll, who runs fund sponsor and asset manager WisdomTree Japan, explained to the Financial Times : “ There was no other equity market in the world that covered this sort of fundamental downside protection.” There’s little doubt these huge moves will continue. Last year the Bank of Japan announced it would double its purchases of shares, spending at least 6 trillion yen ($60 billion) on stocks. John Law would be impressed. But remember... About a year after the Mississippi Company went public, food prices began to soar. To stop the runaway inflation, Law had to raise interest rates. That pricked the bubble in Mississippi’s stock. Within a few weeks, the whole scheme collapsed. Food prices soared another 60%, the king outlawed gold, and shares of the Mississippi Company collapsed. YOU CAN’T PRINT PROSPERITY Keep a careful eye on the markets, and especially on the outlook for inflation. It’s

coming. And in the meantime, look at Fast Retailing (9983.T) on the Tokyo Stock Exchange. If you’ve ever seen a pro golfer wearing a brand you can’t pronounce (UNIQLO), then you’ve seen the company’s products. Golfer Adam Scott, for example, is sponsored by UNIQLO, among other major athletes.

You can think of the business as something like the “Japanese Under Armour,” a fast-growing sports apparel business. But unlike Under Armour (UAA), which has very few stores (just 29), Fast Retailing continues to invest heavily in actual physical locations. It has opened more than 1,000 stores since

16 | June 2017

2012 and now operates over 3,000 stores throughout Asia. That’s nearly twice as many locations as Target has in the U.S. (1,807). (See chart to the right.) Physical retail has been a tough business for about a decade, as more and more shoppers prefer to buy everything from books to shoes online. Fast Retailing, on the other hand, has seen its share price soar. Since hitting a low in 2011 below 1,000 yen, the stock price has gone virtually straight up... climbing over 6,000 yen at its recent peak. This soaring share price has helped the company gain access to billions in additional, new capital. In 2016, Fast Retailing took on $2.4 billion in debt (moving its debt to equity leverage ratio from 4x to 47x) and the company’s CEO has announced plans to spend another $11 billion on a huge global expansion, moving into the U.S. and European markets. WHAT IS FAST RETAILING’S SECRET? Is it the mystery of embroidered shirt patches

Fast Retailing Dodges Retail's Long-Term Decline Business 10-Year Share Price Sears (SHLD) -96% JC Penney (JCP) -94% Esprit Clothing -83% Marks and Spencer (MKS.L) -45% Macy's (M) -44% Target (TGT) -14% H&M (HM.STO) 0% Fast Retailing (9983.T) 332%

and Google recently both saw their share price racing to $1,000. (Google won, twice – its shares previously passed the $1,000 prior to its 2014 stock split.) But they’re not the only nominal share price soar. There’s a host of super- expensive nominal share price companies today, like Priceline (PCLN), at $1,890, NVR (NVR) at $2,395, Seaboard Corp (SEB) at $4,150, AutoZone (AZO), at $600, and Intuitive Surgical (ISRG) at $930. Huge nominal share prices companies that have deliberately let their

nobody can pronounce? Is there something unique about its Vietnamese-made shirts...? No, of course not. What’s special about Fast Retailing, at least in the eyes of global investors, is its nominal share price. Not its market capitalization, the sum total value of its shares. The share price itself. Compared to its peers, Fast Retailing has a huge nominal share price, around 37,000 yen. Why should nominal share price matter? You might have noticed the sudden popularity of very large share prices. Amazon

American Consequences | 17

haven’t always been popular. You might remember that during the dot-com boom of the late 1990s, investors would pile into companies that were announcing a stock “split.” That’s when outstanding, sometimes by 100%, by simply exchanging one of your shares for two new ones. Share splits don’t change anything about the business. It doesn’t make the company more valuable in any way. The share price should simply fall in half as the company’s shares outstanding double. But back then, investors believed that simply making the stock more affordable would lead more investors to buy it... and that alone would push the total value of the stock higher. a company increases the number of shares Today, however, most people are investing through exchange-traded funds (“ETFs”). Many of these funds are structured according to various indexes. And some of these indexes are “price-weighted,” meaning that the capital is allocated according to nominal share price .

to split their stock to gain the attention of investors are now not splitting their shares for the exact same reason. And in Japan, that kind of investment rationale has been taken to an extreme... In Japan, the central bank is the “greater fool.” Japan’s central bank – the Bank of Japan – has been buying around 3 trillion yen ($30 billion) worth of stocks via ETFs each year, radically warping the equity market. The Bank of Japan focused its buying on ETFs that were structured according to the Nikkei 225 index, which is a “price weighted” index, much like the Dow Jones Industrial Average. Again, in a price-weighted index, the larger the nominal share price, the larger the allocation in the index. Fast

That is, some people are investing, knowingly or unknowingly, into stocks simply because the nominal price is high . They’re not buying because the business is undervalued.... or because it pays a good dividend... or because it’s growing fast. They’re buying simply because the nominal share price (which conveys zero information about the relative attractiveness of the investment), is a very large number compared its peers and thus is more likely to attract subsequent capital. Said another way, the “greater fool” is more likely to buy a big nominal share price stock over any other stock. Thus, the same kinds of management teams that used

A Price Only a Central Banker Would Love Fast Retailing's share price is around 10-30 times higher than its peers Fast Retailing 37,000 yen Aoyama Trading 3,960 yen United Arrows 3,425 yen Adastria 3,060 yen Nishimatsuya 1,178 yen

18 | June 2017

Retailing, with its huge share price, makes up about 8% of the Nikkei index, a huge position relative to the total size of its company. For comparison, consider that Fast Retailing makes up only 0.3% of the larger Topix index, where allocations are made according to firms’ total market value, not merely the nominal price of their shares. (See chart on the previous page.) It didn’t take long for investors to figure out how to take advantage of the policy. CLSA – one of Asia’s biggest brokerage firms – recommended clients sell shares of auto giant Toyota (7203.T), one of Japan’s best global companies. It replaced Toyota in its recommended portfolio with... Fast Retailing, purely because of its huge weight in the Nikkei 225 index. The broker also recommended Japanese communications giant Softbank (9984.T), which is pursuing a risky, highly leveraged global acquisition strategy. It wasn’t an endorsement of Softbank’s strategy. It was an

endorsement of its nominal share price. You see, after Fast Retailing, Softbank is the second-highest-weighted stock in the Nikkei 225. And sure enough, Softbank’s shares have soared, thanks to the Bank of Japan’s investment scheme. Softbank’s stock was “dead money” due to the collapse of the tech sector until 2012. But once the Bank of Japan ramped up its equity purchases, Softbank’s stock has more than quadrupled, moving from around 2,000 yet to over 9,000 yen. (See chart above.) The decision to use the awesome power of a central bank to invest in the stock market won’t only

hurt investors and “stock jockeys.” THERE IS NO UP, THERE IS NO DOWN Our capital markets are supposed to be “efficient.” That is, modern financial theory explains that by allowing capital to be allocated by the inputs of millions of investors, vast amounts of disparate information can be processed and capital can be allocated where it’s needed most, so it can be used most efficiently. But allocating capital according to nominal share price? And putting the most amount of capital into the stocks with the highest nominal share price? That’s

American Consequences | 19

Sprint hasn’t made a profit since 2006 and will probably run out of money before mid-2018. If Sprint defaults, Softbank will likely lose all of its $21 billion. And what about Fast Retailing? Will building new retail locations all around the world – as Fast Retailing intends to do – prove to be a wise use of capital? Will Japan’s enormous equity purchases, which have supported both Softbank and Fast Retailing, generate real economic growth, by stimulating the economy? Or will this huge inflation only promote reckless speculation and bad investments? What will happen around the world as more countries to try to emulate Japan? Can you successfully back a currency with the shares of highly volatile companies? In 2014, Switzerland’s central bank began buying equities, too. But since its domestic economy is so small, it decided to invest globally... Today, the Swiss central bank owns more than $60 billion worth of U.S. stocks, including a huge $1.7

not likely to be efficient at all. It seems utterly ridiculous, in fact. Why would a company with a high share price be particularly adept at putting more capital to work? What if they’re merely good promoters and have figured out a way to game the system? In 2013, riding the wave of the Bank of Japan’s investing spree, Softbank bought $21 billion worth of America’s fourth-best wireless telecom, Sprint (S). Immediately after the purchase the shares began to decline and eventually fell in half. Sprint, meanwhile, has seen its network investment costs

explode higher (reaching over $9 billion last year) and has had to borrow over $30 billion to remain competitive. Meanwhile, a price war has broken out with the leading vendor of wireless service, Verizon (VZ), knocking of Sprint’s flat-rate pricing offer. During the 2015-2016 correction in corporate bonds, Sprint’s most recently issued debt fell to $0.75 on the dollar, indicating that most investors don’t believe the company is likely to repay these obligations in full. Dennis Saputo, a senior credit analyst at Moody’s Investors Service, told the Wall Street Journal that

By permission Michael Ramirez and Creators Syndicate, Inc.

20 | June 2017

billion position in iPhone maker Apple (AAPL) and $800 million in social-media titan Facebook (FB). And the Swiss bank continues to expand its balance sheet at almost $100 billion a year. Its total balance sheet has now grown to around $700 billion. That’s almost $90,000 in securities per citizen... and growing every year... just by printing more Swiss francs . In M.C. Escher’s most famous prints, the viewer can’t figure out which way is up. In Relativity , a maze of stairs interconnects – each with a different gravity orientation. The paths wind and intertwine. There is no “up.” There is no “down.” (See image to the right.) When central banks around the world begin to spend trillions on financial assets , the same thing happens to the world’s financial markets. When stocks become the basis of our global financial system... stocks are the money we use... there’s no way to exit the risks of the equity markets. There’s no up. There’s no down. There’s no limit to the

resulting possible inflation. And there’s no way to predict when the value of the currency will collapse. When money has no firm value, it’s impossible to

know what something’s actually worth... or if an investment makes sense... or is safe. Today, as stocks rise by huge amounts all over the world, investors are cheering these central-bank moves... But they may rue them tomorrow. After all, if these investments sour, how will investors flee to safety... when inflation forces central banks to stop the inflation and to increase interest rates... how will investors find safety?

will investors seek in a crisis? Official currencies? They too will be tied to the success (or failure) of Apple’s new phone... or of Softbank’s latest gamble. Like an Escher maze, there may be no conventional way out of the next crisis. There may be no way to get to level ground. We’ll look at one possible “out” for investors in our July issue of American money – like Bitcoin. But whatever happens next, just remember... the soaring stock prices you’re seeing aren’t real. They’re just stairs – in a giant financial Escher print. Consequences . We’re focused on gold, oil, and even new forms of

When the Swiss franc is backed by shares of Facebook... and the

Japanese yen is backed by Fast Retailing... and the U.S. dollar is backed by mortgages... what firmament

American Consequences | 21

By P.J. O’Rourke

The Strange, Shape-Shifting Symbol of Value

M oney isn’t the root of all evil. Money is the root of everything . What money is, is necessary. Necessary for good stuff. Necessary for bad stuff. Necessary for all the stuff that comes in between – the stuff of life. But what money also is, is very hard to comprehend. Why’s this soiled, crumpled, over-decorated piece of paper bearing a picture of a man who was something of a failure as a president worth $50? Meanwhile, why’s this clean, soft, white, and cleverly folded piece of paper worth so little that I just blew my nose on it? And it’s not just me who’s confused. All the world’s top economists, powerful central bankers, and leading politicians seem to lack a basic conceptual understanding of money. What exactly is a “dollar”? If it’s a thing that I want, why do I prefer to have 50 grimy old dollars instead of one nice new one? This isn’t true of other things – like

In ancient times, money didn’t exist. Or rather, everything that existed was money. If I sold you a cow for six goats, you were charging it on your Goat Card.

We need economic goods all the time, but we don’t always need money for them. And that’s a good thing, since for most of human existence, there wasn’t any money at all. In ancient times, money didn’t exist. Or rather, everything that existed was money. If I sold you a cow for six goats, you were charging it on your Goat Card. value itself, is “commodity money.” Societies that didn’t have dollar bills picked one or two commodities as proto-greenbacks. The Aztecs used cocoa beans for money, North Africans used salt (the origin of the word “salary”), and medieval Norwegians used butter and dried cod. (Their ATMs were a mess.) Some commodities work Anything that’s used to measure value, if it has

a puppy. Money is not a specific thing. Money is a symbol of things in general, a symbol of how much you want things, and a symbol of how many things you’re going to get. Money is an abstract representation of value. But what is value? The brief answer is “it’s complicated.” Value varies according to time, place, circumstance, and whether the puppy ruined the rug. Plus, some things are difficult to place a value on. This is why we don’t use money to measure all of our exchanges. Kids get food, clothing, and shelter from parents. And in return, parents get... kids. Important emotional, moral, and legal distinctions are made between sex and paying for sex, even if the socially approved kind of sex costs a dinner and a movie.

puppies, for instance. Of course, money is not

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alloy called electrum. It’s hard for anyone but a chemist (and there weren’t any) to tell how much gold is in a piece of electrum versus how much silver. The king of Lydia, Croesus, became proverbial for his wealth. In China, the weight of bronze “cash” was supposed to be guaranteed by death penalties. A lot of people must have gone to the electric chair (or would have if the Chinese had had electricity). A horse cost 4,500 “one cash” coins during the Han dynasty (206 B.C to 220 A.D.) and 25,000 cash during the Tang dynasty (618 A.D. to 907). It’s very hard for the people who issue cash to resist the temptation to debase that cash. Kings, emperors, and even lowly congressional government’s advantage to pay for those expenses with funny money. One reason that the concept of money so often violates common sense is that governments so often do representatives have expenses. It is to a

better as money than others. Celebrities would make bad money. Carrying a couple around would be a bother, and you would have to hack a leg off to make change. Precious metals, however, make good money and have been used that way for more than 5,000 years. Metal commodity money is portioned out by weight. A commodity money coin is just a hunk of precious metal stamped to indicate how

much it weighs. Moving from weighing

money to stamping coins is a simple step, but a couple thousand years passed before the step was taken. Nobody trusted anybody else to do the stamping. When coins were invented, the distrust proved to be well-founded. The first Western coins were minted by the kingdom of Lydia, in what is now Turkey. They were made of a gold-silver

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